Does Media Coverage of Stocks Affect Mutual Funds’ Trading and Performance?
Lily H. Fang
Charlie Munger: Invert And Use “Disconfirming Evidence”
University of California, Irvine
We study the relation between mutual fund trades and mass-media coverage of stocks. Stocks receiving media coverage are more heavily bought by funds in the aggregate. Funds exhibit heterogeneity in their propensity to buy media-covered stocks, and this propensity is negatively related to future fund performance. Funds in the highest propensity decile underperform funds in the lowest propensity decile by 1.5% to 2% per year. These results do not extend to fund sells, likely due to funds’ inability to sell short. Funds with high propensity to buy media-coverage stocks do so persistently. These results suggest that professional investors are subject to limited attention, and such behavior harms their investment performance.
Does Media Coverage of Stocks Affect Mutual Funds’ Trading and Performance? – Introduction
Mass media disseminates information to a broad audience, much more so than traditional corporate channels such as company disclosures or analyst reports. Thus, mass media coverage is a good proxy for the amount of attention market participants pay to a particular event, even if it does not contain the latest news. In fact, corporate news is typically first released on business newswires and often appears in mass media only with a delay. The recent literature provides increasing evidence of a connection between media and the stock market.1 Does mass media coverage affect the investment behavior of professional investors? In this paper, we investigate how the media coverage of stocks affects mutual funds’ trading and performance. Specifically, we analyze funds’ propensity to buy and sell stocks covered by the media. We then examine whether the cross-sectional variation in this propensity predicts fund performance.
It is easy to see how individual investors’ investment decisions may be influenced by the media. Buying and selling a stock involve a sequence of decisions that require the investor’s attention, a scarce cognitive resource (Kahneman (1973)). After all, an investor is unlikely to “pull the trigger” on a stock trade unless he has paid some attention to the stock. For individual investors who typically lack the capabilities to learn about many securities, media coverage can play a significant role in familiarizing them with certain stocks and putting these stocks on their radar screen. There is increasing evidence that individual investors are more likely to trade “attention grabbing” stocks such as those featured in the media (e.g., Barber and Odean (2008)).
How mass media affects the behaviors of mutual fund managers, however, is much less clear. Due to lead-times in the editorial process, mass print media—in contrast to professional newswires—is unlikely to convey genuine news to the market. In an efficient market, fund managers are thus unlikely to be able to generate superior returns by reacting to articles in The Wall Street Journal, for example, and as such, their trades and performance may not be related to mass-media coverage at all. This is our null hypothesis.
On the other hand, moving away from informational efficiency, there are two opposing reasons why professional traders may favor highly covered stocks. First, if fund managers-like retail investors-suffer from limited attention, then their investment decisions could be influenced by “attention-grabbing” media coverage. Identifying stocks to buy from thousands of potential names involves a high search cost. By drawing attention to the mentioned stocks, mass media lowers the search cost associated with these stocks, making investors more likely to trade them than those out of the media lime light. But because such trading behavior is not motivated by superior information and instead reflects a shortage of cognitive resources, we expect this trading pattern to be associated with inferior investment performance. We call this the “limited attention hypothesis”. Under this hypothesis, we also expect the correlation between media coverage and trades to be stronger for buys than for sells, because of the presence of short-sale constraints: while the manager needs to identify buy opportunities from the universe of listed stocks, he can only sell what is already in his portfolio, a much smaller set for which limited-attention should be less of a problem.
See full PDF here.